How to Invest Your Money the Way Warren Buffet Would Want

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Paul Morigi/Getty Images for Fortune/Time Inc.Billionaire investor Warren Buffett
By Nicholas Pell

Warren Buffett, the Oracle of Omaha, is pretty much a one-man investing machine. If you're going to follow anyone's example of how to invest, it should be his. But with shares of Berkshire Hathaway trading at over $200,000 each, you can't exactly hitch your star to his wagon. So how do you invest like Buffett in a way that makes sense for your budget, circumstances and family? Lend us your ear.

Don't Pick Stocks

Of course, picking stocks is how Buffett made his fortune, but it's not going to work for you. "If you're not an expert at picking stocks, you have no business picking stocks," says Maz Jadallah, founder and CEO of AlphaClone, a company that uses technology to help people invest wisely. He advises people who aren't experts at picking stocks to throw their money into the S&P 500 (^GSPC) with a 10 percent cash cushion and leave it. "It's so simple it takes your breath away, and that's why it appeals to so many people." It might not be as sexy as day trading, but it's probably what Buffett himself would tell you to do. In fact, it's what's going to happen to his money after he dies.

"If you want to be a passive mutual fund investor, index funds are the place to be," says Steve Wallman, CEO of Folio Investing. "They offer low fees and are reasonably diversified. You're not going to knock it out of the park, but the S&P isn't going to drop to zero like Enron stock."

Still, Wallman admits that there are people who both want a higher return and want to be more engaged. Ultimately, what you can do depends on several factors, including your current income, projected income and responsibilities. Wallman notes the world of difference between a family where two people are working and earning a decent wage with no kids against the same income level with three kids and aging parents to support. In the former case, there's more risk tolerance. In the latter, there's less. "Should you be doing a little bit more or even a little less with your money?" he asks. "It depends on your circumstances." Still, no matter what you decide, Wallman thinks you should have an index fund as part of your investment strategy.

Manager Selection Is Even Harder

"The biggest pain point is manager selection," says Jadallah. Because even when you concede that you're not the best person to manage your money, that doesn't mean you know who the right person to manage your money is. AlphaClone's entire business model is helping people to pick competent money managers based on their previous track records using current technology.

He points out that there are basically three problems when investing. Market risk is the risk of the overall market. This is an area where you have zero control. Company risk is the risk specific to the company your manager is investing in and can be mitigated by picking the right manager. Finally, there's the manager risk, which is where the rubber meets the road. So look for a manager who isn't putting all your eggs in one basket and knows how to mitigate market and company risk.

Don't Go All Long or All Short

Jadallah says that one mistake people make is that they go "all long." This means they put all their money into an exchange-traded fund that tracks an index like the S&P 500. And while Buffett is bullish on the ETFs, urging investors to put 90 percent of their money there, he also keeps a 10 percent cash cushion in the form of short-term bonds. For his part, Jadallah suggests that you increase that to 20 percent. "If the market has a 40 percent drawdown event, it takes years to recover," he says. "You want to align with what the market is doing over a long-term trend." Do that, he adds, while also having something to protect you in the event of a major drawdown event.

Find Funds that Are Diversified

One of the main reasons the S&P 500 is such a safe bet is that it's diversified. "Having 10 airline stocks isn't being diversified," says Wallman. In fact, it's an incredibly concentrated way of investing, but that doesn't stop a lot of investors from investing primarily in tech, energy or other industry-specific stocks. Here you're not getting much of the benefit of an index fund at all. You're sharpening your overall market risks, because when you invest heavily in one specific industry, the entire economy doesn't have to have a downturn -- just the one that you're in.
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